Commvault Systems, Inc. (NASDAQ:CVLT) Q3 2024 Earnings Call Transcript

Commvault Systems, Inc. (NASDAQ:CVLT) Q3 2024 Earnings Call Transcript January 30, 2024

Commvault Systems, Inc. beats earnings expectations. Reported EPS is $0.78, expectations were $0.73. Commvault Systems, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Michael Melnyk: Good morning. And welcome to our earnings conference call. I’m, Michael Melnyk, Head of Investor Relations and I’m joined by Sanjay Mirchandani, Commvault CEO and Gary Merrill, Commvault CFO. An earnings presentation with key financial and operating metrics is posted on the investor relations website for reference. Statements made on today’s call will include forward-looking statements that are of Commvault. Future expectations plans and prospects. All such forward-looking statements are subject to risks, uncertainties and assumptions. Please refer to the cautionary language in today’s earnings release and Commvault’s most recent periodic reports filed with the SEC for a discussion of the risks and uncertainties that could cause the company’s actual results to be materially different from those contemplated in these forward-looking statements.

Commvault does not assume any obligation to update these statements. During this call, Commvault’s financial results are presented on a non-GAAP basis. A reconciliation between non-GAAP and GAAP measures can be found on our website. Thank you again for joining us. Now I’ll turn it over to Sanjay for his opening remarks. Sanjay?

Sanjay Mirchandani: Thank you, Mike. Good morning and thanks for joining us today. I am pleased to report our Q3 results exceeded expectations including double-digit year-over-year growth across our most important KPIs. By our own metrics, this was an exceptional quarter. We also set the stage for the future by introducing market-leading innovation. With Commvault Cloud, our revolutionary platform for cyber resilience. Some financial highlights include total revenue increased 11% year-over-year to $217 million. This was driven by a 31% increase in subscription revenue, which now represents more than half of our total revenue. Total ARR, the primary metric we use to measure underlying growth, grew 17% year-over-year to over three quarters of a billion dollars.

Subscription ARR grew 29% year-over-year to $571 million, and is now over 75% of total ARR. SaaS ARR increased 77% year-over-year to $152 million, and we expanded operating margins by 180 basis points year-over-year while continuing to repurchase shares. These results reinforce that Commvault’s products and services are in more demand than ever, especially as companies grapple with how to keep their data secure, compliant, and resilient in a world increasingly under threat of cyber-attacks. For two years now, we’ve discussed how the volume, intensity, and sophistication of cyber-attacks would require a radically different approach to cyber resiliency. Gone are the days when perimeter security alone would suffice. It’s just a matter of time until the bad actors get in.

So rather than just looking at prevention, CIOs and CISOs alike are putting a heavy emphasis on recovery and resilience. This transition has fueled the most important pivot in our 27-year history. In November, we introduced Commvault Cloud powered by Metallic AI. This platform brings together the best of all worlds. Industry-leading data protection combined with data security, data intelligence, and recovery. Commvault Cloud offers the fastest, most reliable recovery of any solution on the market today. With our platform, data can be restored from anywhere to anywhere, rapidly, reliably, and at massive scale. The platform provides AI capabilities, giving customers automated and predictive recovery, threat intelligence, and operational efficiencies to deliver true cyber resilience.

No longer will organizations need to make unnatural choices between SaaS and other data center workloads. With our platform, we support more workloads than any other vendor in our space. And we do all of this at the lowest total cost of ownership. We scale the platform, integrating with major hyperscalers, as well as leading cyber security and AI companies like Avira, Darktrace, Databricks, Microsoft Sentinel and Palo Alto Networks among others. I’m pleased to share that customers, partners, and industry analysts have been raving about. For instance, one customer told analyst firm Enterprise Strategy Group, quote, “We’re a highly regulated industry. Commvault Cloud was the only solution we found that gives us the flexibility and assurance that satisfied our auditors.

Because of Commvault Cloud, I can assure our leadership team that we are protected and we all sleep better at night”. IDC Research Vice President Phil Goodwin said, “This announcement realigns Commvault’s products to meet customer preferences and sets the company on a path to be very competitive in cyber resilience”. And we continue to introduce major innovations in the platform that solve critical customer challenges. For example, with our clean room recovery offering, we are closing the gap that exists between incident response planning and readiness. Our new clean room recovery capabilities enable customers to thoroughly and cost effectively test their recovery plans. It also provides them with a safe, on-demand environment to recover.

It is this kind of groundbreaking innovation that sets us apart from the competition and helps us take share and land new business. In fiscal Q3, we added another 500 subscription customers, bringing our total to almost 9,000. Subscription customers now represent well over half of our total active customer base. A couple of examples include a large state agency that detected security gaps with its incumbent vendor. This new customer turned to Commvault for immutable Air Gap ransomware protection, anomaly detection, and an improved cyber resilience posture. And we also helped the Fortune 500 Capital Equipment Company eliminate its patchwork of vendors and move their workloads onto our unified platform. This allowed them to modernize and improve their cyber resilience posture, better protecting them from ransomware with a lower total cost of ownership.

To expand our perspective and keep us at the forefront of innovation, we also established a Cyber Resilience Council comprised of security visionaries from top cyber, cloud and government organizations. The council would advise on security trends and cyber threats, which will shape product development, strategy and partnering opportunities. It is chaired by Melissa Hathaway, a thought leader in cybersecurity and digital risk management, who served in two presidential administrations. We’re two months away from closing our fiscal year and I couldn’t be more excited about our momentum as we approach fiscal year 2025. With that, I’ll turn it over to Gary to discuss our results. Gary?

Gary Merrill: Thanks Sanjay and good morning everyone. I am pleased to report strong revenue and earnings outperformance in Q3. Starting with the top line, total revenue was $217 million, an increase of 11% year-over-year and significantly outpaced our Q3 expectations. Our total revenue growth was highlighted by a 31% year-over-year increase in subscription revenue to $114 million, reflective of both solid double-digit growth in term software licenses and an accelerating contribution of SaaS revenue. Our execution was strong as large software deal close rates improved sequentially and we delivered against our largest term subscription renewal quarter of the fiscal year. This execution resulted in term software deals over $100,000, up 25% year-over-year, driven by increases in both average selling price and deal volume.

Q3 perpetual license revenue was $15 million as these perpetual licenses are generally sold in limited verticals and geographies. At the current run rate, we believe that the headwinds to our reported total revenue growth for perpetual license sales are normalizing as we exit the current fiscal year. Q3 customer support revenue, which includes support for both our term-based and perpetual software licenses, was $77 million, down just 1% year-over-year. Q3 and fiscal year 2024 continue to benefit from the continued trend of fewer conversions of perpetual support contracts to term software licenses. Year-to-date, customer support revenue from perpetual licenses represents 54% of total customer support, with a balance coming from term software and related arrangements.

This compares to approximately 60% in fiscal year 2023 and 75% in fiscal year 2022. At this trajectory, we expect customer support revenue from term-based software licenses to become the majority of our customer support revenue next fiscal year. Moving from revenue results to ARR. Q3 ARR was $752 million, representing 17% year-over-year growth and continues to reflect the underlying strength of our business when our revenue is presented on an annualized basis. Subscription ARR, which includes term-based software arrangements and SaaS contracts, increased 29% year-over-year to $571 million. Within subscription, SaaS ARR grew 77% year-over-year to $152 million, driven by new customer acquisition and strong expansion with existing customers. Q3 SaaS net dollar retention rate, or NRR, was a healthy 125%.

Now I’ll discuss expenses and profitability. Fiscal Q3 gross margins increased 90 basis points sequentially to 82.9% and includes continued improvement in our SaaS gross margins. Fiscal Q3 operating expenses were $132 million, up 9% year-over-year, reflecting the impact of our planned go-to-market investments throughout fiscal year 2024 and higher marketing spend during the quarter, including our shift event in New York City. Overall, operating expenses as a percentage of total revenue was 61%, representing 100 basis points of leverage year-over-year, consistent with our objective to manage expenses relative to revenue results. We ended the quarter with a global headcount of approximately 2,900 employees, last sequentially and up 3% year-over-year.

Our current headcount balance includes additional inside sales teams, renewal and related customer success teams to support the customer journey and our accelerating velocity sales motion. Non-GAAP EBIT for Q3 increased 21% year-over-year to $47 million. And non-GAAP EBIT margins increased 180 basis points year-over-year to 21.5%. Moving to some key balance sheet and cash flow metrics. We ended the quarter with no debt and $284 million in cash, of which $88 million was in the United States. Our Q3 free cash flow grew 45% year-over-year to $43 million. Through the first three quarters of the fiscal year, we generated $121 million of free cash flow, an increase of 20% year-on-year. The biggest drivers of free cash flow were SaaS deferred revenue and the strength of our software subscription renewals, which typically include upfront payment on multi-year contracts.

In Q3, we repurchased $51 million of stock under our repurchase program, resulting in year-to-date repurchases totaling $134 million, representing 111% of year-to-date free cash flow. Now I’ll discuss our outlook for fiscal Q4 and the full fiscal year 2024. All of the following guidance metrics are based on current foreign currency exchange rates. For fiscal Q4, we expect subscription revenue, which includes both the software portion of term-based licenses and SaaS, to be $111 to $115 million. This represents 20% year-over-year growth at the midpoint. This Q4 subscription revenue outlook reflects continued momentum in our new customer and expansion business, but a smaller renewal pull in fiscal Q4 relative to Q3. As a result, we expect total revenue to be $210 to $214 million.

At these revenue levels, we expect Q4 consolidated growth margins to be in the range of 81% to 82%, and EBIT margins in the range of 20% to 21%. We continue to execute some foundational go-to market changes, which include amplifying our discrete focus on our land and expand opportunities, scaling our motion to secure our growing subscription renewal base, and investing to capitalize on our fiscal year 2025 growth objectives. These investments are reflected in the range of our Q4 margin guidance. Our projected diluted share count for fiscal Q4 is approximately 44.5 million shares. Now, I want to give an updated outlook on the full fiscal year 2024, which includes, once again, raising our total revenue and total ARR expectations for the full year.

We expect fiscal year 2024 total ARR growth of 15% year-over-year, which reflects a 100 basis point increase over our prior guidance. We now expect subscription ARR, which includes term-based licenses and SaaS, to increase 25% year-over-year, and reflects a similar 100 basis point increase over our prior guidance. From a revenue perspective, we now expect subscription revenue to be in the range of $420 million to $424 million, growing 21% year-over-year at the midpoint, reflecting the continued momentum in our business and is a $9 million increase at the midpoint compared to our prior guidance. At these revenue levels, subscription revenue will exceed over 50% of our total revenues for the full year. We expect total revenue to be in the range of $826 million to $830 million, reflecting an $11 million increase at the midpoint compared to our prior guidance.

Our improved fiscal year 2024 total revenue outlook reflects the seasonally stronger subscription software trends that we usually experience in the second half of the fiscal year combined with the ongoing momentum of our SaaS offerings. Moving to full year fiscal 2024 margin, EBIT and cash flow outlook. We continue to expect gross margins of 82% to 83% and non-GAAP EBIT margin expansion of 50 to 100 basis points year-over-year. We are also maintaining our expected full year free cash flows of $170 million. As of December 31st, we had $122 million remaining on our existing share repurchase authorization and we expect to continue with our existing practice of repurchasing at least 75% of our annual free cash flows. Year-to-date, we are pacing well ahead of this target and we intend to continue the share repurchase momentum during the current quarter.

For details and trends on all of our key metrics, please take time to review our investor deck contained on the investor relations section of our website. Operator, you can now open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Aaron Rakers of Wells Fargo. Your line is open.

Aaron Rakers: Thanks guys, for taking the question and congrats on the good quarter. I guess the first question, and I appreciate that you’re not going to give guidance looking out into fiscal 2025, but I’m just curious with the momentum you’re seeing in subscription and obviously the SaaS business as well, how do you guys start to think about seasonality and in particular thinking about the March quarter? And I guess I’ll layer into that. How do we think about the customer support growth as that starts to, the rate of decline starts to ease and maybe we return to growth as we look into next fiscal year?

Gary Merrill: Hey, Aaron. Good morning. It’s Gary. Nice to hear from you. I’ll start off. You asked a couple of different things. Maybe I’ll start with the Q4 piece of it, the current March quarter perspective. So Q3, just looking back at the quarter we just finished was a really significant quarter for us by our own measures. It’s one of the best, if not the best quarter we’ve ever had. We’re really starting to see that cyber is changing the way that people are buying. Some of the trend that we saw during that quarter gave us the confidence to raise both our Q4 and full year numbers. As you mentioned about specifically subscription revenue, our guide is less than about 20% growth year-over-year at the midpoint. What we’re seeing and what we’re expecting in fiscal Q4 is continued momentum in that land and expand motion.

Also, the SaaS revenue that we’re now generating is a tailwind and provides more predictability to our P&L. Those together will see a slightly smaller renewal opportunity in fiscal Q4 relative to Q3. That’s also reflected into our guidance as fiscal Q3 had the largest renewal pool we’ve ever had in our history. We think those trends, along with continued execution and some really good acceleration in our partner ecosystem is really going to help us set the foundation for next year. What’s also helping, as you mentioned, relative to our total revenue is what’s happening in the customer support revenue. And what you see there is that the declines year-over-year are starting to get mitigated and now down into the low single digits. Some of that’s reflective of fewer conversions that I mentioned on last call.

We continue to see fewer conversions that then eliminate some of the headwinds we see in support. So some of those headwinds will get mitigated going into next fiscal year, which would also provide some of that continued momentum, we’ll see.

Aaron Rakers: Yes, Gary, I appreciate that. Let me maybe kind of double-click on that and just ask more succinctly, do you think the customer support revenue can turn to growth as we look into next fiscal year?

Gary Merrill: No, I would say, as I look into next fiscal year, I would say flat to slightly down is what I would expect on a full-year basis. Aaron is what I would expect at this point. I think by the end of next fiscal year, the term component, like the maintenance and support piece from our term licenses, will become the majority of that customer support. But I think that will take us into the back half of next year, which means that on a full-year basis, we’ll slightly be kind of probably low single digits down.

Aaron Rakers: Yes, that’s helpful. And then the final quick question, on the term side, can you just talk about what you’re seeing from a term perspective, the term length of the deals you’re engaged with? It sounds like large deals have improved. The macro might have eased. So just kind of any updated thoughts on what you’re seeing, any kind of term lengths or term compression dynamics?

Gary Merrill: Yes, absolutely. So what we continue to see now is stabilization in our term length. Last quarter, we saw, I’d say, the first quarter stabilization. This quarter, we saw another quarter stabilization. On the subscription side, our average term is still rounding to about two years. But that stabilization, which is also demonstrated by good execution, but also demand for our cyber-resilient products, is also giving a little more predictability in there. The other piece there, and that’s also critical to this, is how we align with the partner ecosystem. Those bigger deals and larger transformational projects are tied with some of the new modern partner ecosystem, whether it be hyperscalers or others. And they also provide some foundational support for keeping that term length healthy.

Sanjay Mirchandani: Hey, Aaron and Sanjay, I’ll just add one more point. As customers start really moving and pivoting to the hybrid model and hybrid cloud workloads, our platform allows them to do that mitigation and move their workloads and have the same technology support them, both in the cloud and data-centric. So we’re seeing that as well. That’s helping as well.

Aaron Rakers: Thanks, guys.

Operator: Your next question comes from the line of Howard Ma with Guggenheim Securities. Your line is open.

Howard Ma: Great. Thanks. And impressive results. I have a question first for Sanjay. Sanjay, if you were to dissect the outperformance in the quarter, I guess between the general spending environment maybe improving, it looks like it might be an in secular tailwind of a consolidating or increasing infrastructure and security budget. That versus your own internal execution, so new product initiatives and go-to-market execution. And I understand it might be hard to separate the internal from external. But if you were to force the stack rank, the internal versus external, I’m curious what your thoughts would be.

Sanjay Mirchandani: Well, I would say it’s probably 75% for this quarter that passed, 75% internal. And I would say that because really, Howard, Gary touched on this. Our own business transformation, moving our install base of customers and our new customers into a more routable format as well as a subscription-oriented format is actually working. Our subscription renewal tailwind is kicking in. So the stuff that was a headwind for us two, three years ago is actually becoming a nice tailwind. And this last quarter was testimony to that. We’ve also been, we’ve talked about our execution internally, really aligning our sales force, our marketing campaigns, our demand generation campaigns, all the things that you’d expect to avail of the opportunity in front of us around cyber.

So that’s kicking in nicely as well. And green shoots on some of the demand we’re seeing on cyber resilience. And the third is the new platform, the platform, the actual Commvault Cloud-powered by Metallic AI platform that we’re seeding into customers at this point. Technologies like cleanroom [ph] recovery are really beginning to get customers’ attention. So if you, not perfect math, but I’d say 75% of what we’re seeing is a combination of what we’re doing and good execution alongside the fact that we’re solving the problem externally. We’re solving a really hard problem for customers. Cyber threats are real, and what we’re able to do for them is meaningful.

Howard Ma: Okay, that’s really good color, and thank you for quantifying that, Sanjay. I have a follow-up for Gary. Gary, with the recent launch of Commvault Cloud and these new security bundles, can you give us some numbers around initial traction in cross-selling these security modules to existing customers as well as adoption by net new logos? Thanks.

Gary Merrill: Yes, good morning, Howard. I’d like to help begin this morning. So a couple things is, as you know, our announcements related to our new platform, Commvault Cloud just hit the market just a couple months ago, okay? So where we’re focused now is on demand gen. So in starting to see some of the early benefits that we start to see in our pipeline and in the funnel that we’re creating, that’s also reflected in our Q4 outlook, okay? What this will do is it’s going to give us an amazing opportunity for expansion as well. None of that is reflective in our results for Q3. So our results in Q3, as Sanjay said, was about executing against the pipeline. We had strong close rates that accelerated quarter-on-quarter. And what we’re seeing now is building that demand gen for next fiscal year and the ability to cross out through our install base.

We finally have a platform that makes the buying process for customers easy between software and SaaS and facilitates that expansion opportunity to go from our foundational model that we have today all the way through the cyber resilience offering that we’ve announced.